Last Wednesday, only two out of 31 big banks failed the Federal Reserve's "qualitative" round of bank stress tests.
And then on Thursday, Santander's biggest U.S. unit, Santander Consumer USA, was able to sell a bundle of subprime auto loans, worth $712 million, in a matter of hours.
Today I'm going to show you why this bond deal matters – and how it proves that the worst history always repeats itself…
Reward for Failure
Santander passed the Fed's first round of bank stress tests the week before, the so-called "quantitative" round that measures how much capital banks have. But it failed the second round, which is about the quality of capital management and risk management relative to what a bank says it would like to do with excess capital.
Most banks want to "reward shareholders" by increasing their dividend payouts or announcing share buyback programs. They think that's a good way to spend their excess capital. Which makes sense, because investors think banks are safe and sound and flush with capital if they're rewarding shareholders.
(That's something of a confidence trick, of course. Increasing equity by getting shareholders to buy shares and lift share prices just happens to be a neat way to get regulators off their backs.)
Anyway, in Round 2 of the stress tests, Santander was wrist-slapped for "critical deficiencies" in areas of "risk identification and risk management."
So, how is it that the very next day investors lined up to buy the Spain-based bank's subprime auto bonds that Moody's Investor Service estimated could see losses of 27%?
Surely investors know that Santander has received subpoenas from federal and state agencies looking into how subprime auto loans are made at the dealer level to folks who don't have jobs and who sometimes use an infant's Social Security number for credit verification?
If those investors read the bond documents, they must have noticed that 13% of borrowers didn't even have a FICO score.
These institutional buyers are smart men and women, so they must know that subprime auto loans (loans on credit scores lower than 640) have doubled since the credit crisis of 2007-2008 and that delinquencies and repossessions are rising.
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.